CONSIDER THESE ISSUES BEFORE CLOSING ON PROPERTY HELD FOR INVESTMENT
Assume a North Carolina taxpayer has held an investment property for many years and will have $500,000 in net proceeds after closing. Also assume this property has $500,000 of capital gain and $200,000 of this gain is due to depreciation recapture. As you can see in the comparison below, the taxpayer who performs a 1031 exchange can obtain considerably higher investment returns from deferring the payment of capital gain taxes and other taxes. The potential to obtain a low rate for financing can provide a unique opportunity for taxpayers to lock-in excellent loan terms. Taxpayers should explore the possibility of exchanging before closing on the sale of investment property and review with their tax advisor.
|SALE (CASH OUT) ||1031 Exchange (Reinvest)|
|Capital Gain Taxes Owed||$121,250 *||$0 (no taxes owed in the current tax year) |
|Net Income to Invest||$378,750 (proceeds less taxes owed) 1-5% possible cash flow (assume 3%) ||$500,000 (entire amount of proceeds received). Many real estate investments provide 6-10% cash flow (assume 8%) |
|Possible Income||Bank CD, Bond Fund, Money Market. Assuming a 3% ** return on $378,750 |
|Residential Rental, Commercial, Agricultural Land, etc. Assuming a 8% return on 500,000 |
|Preferential Tax Treatment ||Income is not tax-favored if earnings are in a non tax-qualified account. May be fully taxable. ||Income generated is tax-favored. Income can be partially sheltered with write-offs. Depreciation tax benefits are also available. |
|Liquidity||Very liquid if 100% cash ||Real estate is generally not very liquid. |
|Diversification||Yes||Yes, but must reinvest in real property. May diversify by asset class and/or geography. |
|Time Restrictions||None||Yes, 45 days to identify replacement property. Maximum of 180 days to close on replacement property. |
|Replacement Asset Basics||Basis equals purchase price||Only partial basis for new depreciation. |
Basis equals purchase price minus deferred gain.
* Depreciation Recapture: $200,000 x 25% = $50,000; Remaining Federal Capital Gain: $300,000 x 15% = $45,000; State Taxes: $500,000 x 5.25% = $26,250
Total Capital Gain Taxes = $121,250; After-Tax Proceeds Available: $500,000 - $121,250 = $378,750
** Today’s inordinately low rates of return for money market accounts, bank CDs and other liquid investments tilt the consideration in favor of exchanging.
This material does not constitute an offer to sell, solicitation of an offer to buy, recommendation to buy, or representation as the suitability or appropriateness of any security, financial product or instrument, unless explicitly stated as such. This information should not be construed as legal, regulatory, tax, personalized investment, or accounting advice. This message (and any attached materials) is for the sole use of the intended recipient(s) and may contain information that is privileged, confidential and exempt from disclosure under applicable law. Any review, dissemination, distribution or duplication of this communication is strictly prohibited
This data is not meant to replace Adviser’s portfolio management/performance reporting systems or brokerage statements. Please consult your reports for actual performance data before making any decisions based on this information. Accordingly, reliance upon information in this data is at the sole discretion of the reader. Assumptions on returns are just that and may or may not come to fruition. Actual returns may not be as projected and are for illustrative purposes only.
Neither EFR (Exclusive Financial Resources, LLC), it’s officers or employees are authorized or permitted under applicable laws to provide tax or legal advice to any client or prospective client of EFR. The tax related information contained herein or in any other communication that you may have with a representative of EFR should not be construed as tax or legal advice specific to your situation and should not be relied upon in making any business, legal or tax related decision. A proper evaluation of the benefits and risks associated with a particular transaction or tax return position often requires advice from a competent tax and/or legal advisor familiar with your specific transaction, objectives and the relevant facts. We strongly urge you to involve your tax and/or legal advisor (or to seek such advice) in any significant real estate or business related transaction.
If you would like to find out more about Sales vs Exchanges please give Exclusive Financial Resources a call at (980) 242-2533, email Louis Herford at Louis.Herford@ExclusiveFinancialResources.com or schedule a 15-minute discussion here.